by Steven Briggs
Chairman & CEO
Briggs Financial Inc.
Author Note: This was submitted in partial fulfillment of the requirement for the degree of Master of Science in Personal Financial Planning.
A number of policy changes pertaining to how retirement accounts and other retirement-age mechanisms are either being proposed or have already been penned into law. These changes will have a significant and lasting impact in how retirement accounts as well as how the social safety net functions in our society both now and in the future. While these changes are touted for the qualities that may exist in them, there are a number of consequences that will likely result in a weaker financial foundation for younger generations, particularly for Gen X and Millennial-aged individuals. Moreover, some of these changes may also have significant wealth transference consequences, potentially creating and perpetuating systemic financial racial discrimination along with a growing percentage of the population that ultimately ends up becoming a ward of the state. This paper will study the underlying motivations and factors driving these policy changes, ramifications of these policy decisions including both intended and unintended social consequences, and what other steps can be taken to answer long-term budgetary risks.
Consequences of Proposed Changes to Retirement Policies
Two years ago, in spite of all the political tensions that existed even before the 2020 election season and the nearly two years that COVID has plagued us, Congress agreed on something. They agreed to a series of reforms to the rules of how retirement distributions work, revising decades of policy in a quiet end-of-year maneuver, passing easily through both chambers and signed by President Trump into law prior to the end of the year.
These changes included some large revisions involving estate planning as well as a seemingly innocuous shift in the age for required minimum distributions, or RMD’s. RMD’s are an IRS-required distribution of assets from a taxpayer’s qualified retirement accounts that have had taxes deferred, such as a 401(k) or Traditional IRA. It also closed what had been a major estate planning loophole, which previously had allowed these sorts of accounts to be inherited and grow tax-free for decades. All of this looks virtuous at face value. However, the concern that is raised goes beyond the substance of what was being agreed to. There was a willingness and spirit of cooperation from both Republicans and Democrats to make these sweeping decisions. The combination of a willingness to act and a lack of resistance to make these adjustments could portend more changes with greater velocity in future years.
This paper will examine several key vectors of change being considered both to reduce the government’s liabilities and to increase its revenues in the future, and the long-term consequences such changes may bare on younger generations of workers. It will start by identifying what exactly is motivating changes in retirement policies, followed by examining several key proposed changes and the expected consequences of each. Finally, this paper will look at the overall financial and sociological impact of these changes, along with alternatives in how to approach these issues.
What is Motivating Changes in Retirement Policies
It is no secret that major social programs at both the federal and state levels of governance are significantly underfunded. Medicare, Medicaid, Social Security, and Income Security have been discussed for decades as being significantly underfunded. But the clock, which was already running out, has now been accelerated as a result of the COVID-19 pandemic with significantly more citizens and hospitals needing the resources of these programs than previously projected. Moreover, the largest aging population in the history of the United States will need an increasing amount of these services, putting further pressure on their respective budgets and resources. This section will examine these key programs and dynamics, as well as how we got into the position we are currently in.
Medicare is the federal health insurance program for both people age 65 and older as well as younger people with long-term disabilities. According to the Kaiser Family Foundation, 18% of Americans nationally are currently enrolled in the Medicare system (Kaiser, March 2019). The Social Security Act divides the scope and funding of Medicare into two trust funds – the Hospital Insurance (HI) trust fund and the Supplemental Medical Insurance (SMI) trust fund.
HI Trust Fund
The HI trust fund is what finances Medicare Part A, which includes health care services related to “inpatient care in a hospital, skilled nursing facility care, nursing home care that is not long-term, hospice care, and home health care” (U.S. Centers for Medicare and Medicaid Services, n.d.). According to the latest report from the board of trustees of the HI trust fund, the fund is projected to be entirely depleted in 2026, due to a lack of funding stemming from the HI trust not meeting “the Trustees’ formal test of short-range financial adequacy since 2003” (The Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2021, p.8). This projection year of 2026 has not changed since the Trustees’ report in 2018, meaning that for the last four years, while the Trustees’ have been reporting that the house is on fire with respect to the deficit trajectory the HI trust fund has been on, nothing has been done to significantly affect this course. Moreover, in a comparison of the 2018 projections, income is projected to be on average 4% lower per year than previously forecasted through 2027, with expenditures just 2.77% lower per year than previously forecasted.
The fund’s primary income is payroll taxes, which comprise 87.2% of its total funding (Kaiser Family Foundation, 2019). However, in spite of expected increases in projected income for the fund, the Trustees project that not only will HI cost continue to exceed the income rate through 2045, but that even if there is no adjustment to the income threshold where the additional 0.9 percent payroll tax would apply, by 2095 the HI trust would still be underfunded annually (The Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2021, p.30). This long-term funding failure has been tested by the Trustees since 1991; not once has it passed.
SMI Trust Fund
The SMI trust fund is what finances Medicare Parts B and D. Medicare Part B covers physician services, preventive services, clinical research, ambulance services, and supplies, whereas Part D is prescription drug coverage (U.S. Centers for Medicare and Medicaid Services, n.d.). Unlike the HI trust fund, SMI is primarily funded by general revenue, such as income and corporate taxes, as well as insurance premiums on Parts B and D. General revenues account for 71.5% of overall funding, with insurance premiums amount to 24.3% of overall funding, accounting for nearly 96% of overall funding (Kaiser Family Foundation, March 2019).
With respect to fund sourcing, the SMI trust fund faces similar pressures to the HI trust fund even though the funding sources are different. Actuarial projections suggest that by 2030, 12.9 million more people, an increase of 22%, will be enrolled in Medicare Part B, and for Medicare Part D, enrollment is expected to rise by 23.8% to nearly 62 million in the next eight years, an increase of 11.9 million enrollees (The Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2021, p.181). Moreover, the cost of health care has increased by 4.3% annually from 2009 to 2019, with Medicare rising 4.8% annually over that same decade (Rama, May 2021).
Medicaid is a federal-state national health insurance program specifically for low-income Americans. According to Rudowitz et. al., “Medicaid finances nearly a fifth of all personal health care spending in the U.S., providing significant financing for hospitals, community health centers, physicians, nursing, homes, and jobs in the health care sector” (Rudowitz et. al., February 2020, p.1). Federal law requires states to cover certain classes of mandatory eligibility groups and benefits, while leaving considerable latitude to the states as to whether they provide additional benefits, expand population coverage, and how providers are compensated. As such, there is considerable variability from state to state as to what Medicaid offers.
Current Demographics of Medicaid
As of 2019, Medicaid services a total population of nearly 88 million Americans (Kaiser Family Foundation, December 2021). Of those 88 million Americans, 8.5 million are seniors (age 65 and older) and another 10 million are individuals with disabilities. Yet this population of 18.5 million, 21% of the total Medicaid population, accounts for nearly two-thirds of all Medicaid spending (Rudowitz et. al., February 2020, p.1). That’s because each individual with disabilities costs 5.3 times more than the average adult, and each senior individual costs 4.2 times more than the average adult. According to Rudowitz et. al., long-term care is a major component of cost in both of these populations, accounting for 37% of total care cost for individuals with disabilities and 68% of seniors (Rudowitz et. al., February 2020, p.9).
Medicaid is funded as a combination of both federal and state funds, with at least 50% of funds provided by the federal government. States with higher levels of GDP per capita tend to be closer to that 50% threshold, while poorer states can range as high as 73.1% of their Medicaid funded with federal dollars (Snyder & Rudowitz, December 2016). States have considerable flexibility when it comes to how they fund Medicaid and the scope of what and whom Medicaid covers, so while many states use general funds to pay for their portion of Medicaid expenses, some use other forms of taxation to supplement the funding of Medicaid. The share of state general funds used has grown considerably from 14-15% in the 1990’s to 16-17.5% in the 2000’s to 20% as of 2016 (Medicaid and CHIP Payment Access Commission, March 2020). With federal and state dollars combined, nearly 30 cents of every dollar in state budgets nationally are spent on Medicaid (Kaiser Family Foundation, April 2021).
Social Security is funded through payroll taxation that is either split between the employee and employer or paid entirely by a self-employed individual. The tax rate overall is 12.4%, and in 2022 this tax is applied to the first $147,000 of earned income. Like Medicare, Social Security is broken into two distinct programs with separate trusts – the Old Age and Survivors Insurance Trust Fund (OASI) and the Disability Insurance Trust Fund (DI).
OASI Trust Fund
The OASI Trust Fund is the trust fund that provides monthly benefits for retired workers, their spouses, and survivors of deceased workers. The trust fund has automatic spending authority, so the Social Security Administration does not need to request money from Congress to pay out benefits. These benefits are paid for primarily by payroll taxes, with minor contributions from the general budget. Based on actuarial estimates from the Trustees of Social Security, OASI is projected to be able to pay scheduled benefits until 2033, at which point the fund’s reserves will be depleted and benefit payouts will be forced to be reduced to 78 percent of scheduled benefits (Social Security Administration, 2021).
DI Trust Fund
The DI Trust Fund is an account that provides benefits specific to disabled-worker beneficiaries and their spouses and children. Similar to the OASI Trust Fund, it has automatic spending authority and does not require formal requests of money from Congress to pay out benefits. While the DI Trust Fund is currently expected to be depleted in 2057, it is important to note that between 2020 and 2021, the actuarial estimate for depletion of this fund accelerated eight years (Social Security Administration, 2021). The Trustees at this point “currently assume that the pandemic will have no net effect on the individual long-range ultimate assumptions,” in spite of data showing that a surge of new enrollees in Medicaid resulted from the COVID-19 pandemic (Social Security Administration, 2021).
Income security, also known as Function 600, consists of programs that are designed to provide various forms of social “safety nets.” Income security is currently the largest source category of spending in the federal budget, accounting for $1.6 trillion. The programs included in this part of the federal budget include unemployment compensation, food and nutrition assistance including food stamps, SNAP and WIC, federal employee retirement and disability including military retirement, housing assistance, the earned income tax credit (EITC), as well as transitory programs such as COVID-19 unemployment compensation and recovery rebates (Datalab, 2021). In 2020, mandatory spending for income security programs was over $1 trillion dollars, amounting to more than double the mandatory outlays just one year prior (Congressional Budget Office, 2021; House Budget Committee Democratic Staff, 2018). Between 2000 and 2019, average mandatory outlays amounted to 11.7% of GDP; in 2020, mandatory outlays comprised 21.8% of GDP (Congressional Budget Office, 2021).
Demographics of Aging Population
It is not a revelation that the United States has a growing aging population. By 2030, more than 73 million Americans will be 65 years of age or older (Vespa et. al., February 2020). According to Medina et. al. “by 2034 adults aged 65 and older are projected to outnumber the population under age 18 for the first time in U.S. history” (Medina et. al., February 2020, p.11). Moreover, according to Medina et. al., total life expectancy is expected to increase another 6.1 years to an all-time high of 85.6 years of age in 2060 (Medina et. al., February 2020).
These trends will have a profound effect long-term on the ethnic background of the population over the next several decades The U.S. Census Bureau projects that “beginning in 2030, net international migration is expected to overtake natural increase as the driver of population growth in the United States because of population aging” as deaths are expected to eventually outpace births (Vespa et. al., February 2020, p.1). This implies a potential increased reliance by the United States in immigration to fill out the population that is not otherwise being naturally born in this country.
This picture in totality implies not only an acceleration in the size of the population of individuals aged 65 and older, but it also suggests that this quality will be persistent – that for the next several decades, we can expect over 20% of the population of the United States to be seniors. It also foreshadows an eventual acceleration and increase in the size of the population that will receive benefits from Social Security and Medicare, but it also implies a massive increase in the number of people likely to need some form of Medicaid support. According to data analysis by Richard Johnson of the Urban Institute, “70% of adults who survive to age 65 develop severe long-term services and supports (LTSS) needs before they die” (Johnson, April 2019, p.3).
While these generalized statistics provide a certain context for how the population as a whole is aging and the size of populations that is expected in the future, these statistics alone do not capture the dynamics that exist within the population. In actuality, there exist multiple and distinct dynamics that create significant differences in outcomes with respect to aging. Three key dynamics that yield significant differentiation with respect to life expectancy in the United States are racial, gender, and financial characteristics.
Racial Characteristics and Aging
Racial characteristics carry a significant weight with respect to life expectancy in the United States. According to the CDC, white people born during the 1950’s and 1960’s live on average over seven years longer than their Black counterparts (Centers for Disease Control and Prevention, 2017, p.1.). This affirms an earlier longitudinal mortality study by Sorlie et. al. which showed that the mortality rate for Black people under the age of 65 was 1.5 to 2 times higher than white people (Sorlie et. al., 1995). White people born in the Gen X and Millennial generations are still expected to live nearly seven years longer than their Black counterparts (Centers for Disease Control and Prevention, 2017, p.1). While the data does suggest that gap shrinking with younger generations to some extent, the vast majority of the white population is expected to live on average over half a decade longer than the Black population. Interestingly, this dynamic is different for the Hispanic population, which has consistently been expected to outlive the white population by about three years (Centers for Disease Control and Prevention, 2017, p.2).
Gender Characteristics and Aging
Gender is another dynamic that demonstrates significant differences in how populations age. Across all OECD countries, females born in 1980 are expected to live an average of 77.4 years, 6.7 years longer than their male counterparts (Centers for Disease Control and Prevention, 2017, p.1). This difference in life expectancy will stay consistent, even as younger generations are expected to live longer. Females born in 2000 are expected to live an average of 80.3 years compared to 74.2 years for males; females born in 2015 are expected to live 83.2 years compared to 77.8 years for men, a difference of 5.4 years (Centers for Disease Control and Prevention, 2017, p.1). The United States exhibits similar gaps between female and male life expectancy, ranging from a 7.4-year gap for those born in 1980 to a difference of 4.8 years for those born in 2015 (Centers for Disease Control and Prevention, 2017, p.1).
Financial Characteristics and Aging
Overall income and financial stability are another key dynamic that significantly impacts life expectancy. According to Chetty et. al., the race and ethnicity-adjusted life expectancy for 40-year-olds in the United States by household income percentile showed that men in the top 1% lived 15 years longer and women lived 10 years longer than men and women in the bottom 1% (Chetty et. al., 2016). A comparison of income quartiles by year in the Chetty et. al. study also demonstrated that “life expectancy did not change for individuals in the bottom 5% of the income distribution, whereas it increased by about 3 years for men and women in the top 5% of income distribution” (Chetty et. al., 2016, p. E14). While the Chetty et. al. study could not outright pinpoint a singular reason for the cause of this disparity, it suggested that the higher income populations adopted more healthful habits, avoiding habits such as smoking, and were generally concentrated in parts of the country with greater access to higher education. This conclusion is supported by previous research from Lantz et. al. which also found that higher income populations had stronger social relationships and support structures and lower levels of chronic stressors (Lantz et. al., 1998).
With respect to financial stability, a key study from Pool et. al. studied the risk of all-cause mortality in middle and older age people who experience a significant loss of wealth; the study defined a negative wealth shock as a loss of 75% or more of total net worth over a 2-year period or asset poverty, meaning zero or negative net worth. According to the study, of the 8,714 participants in their study sample with a mean age of 55 years at the start of the study from 1994-2014, there were 30.6 deaths per 1,000 person-years for those with continuously positive wealth, 64.9 deaths per 1,000 person-years for those with a negative wealth shock, and 73.4 deaths per 1,000 person-years for those who had asset poverty (Pool et. al., 2018). In an earlier study, Lynch et. al. produced similar results, finding that “an appropriate comparison would be that this mortality difference exceeds the combined loss of life from lung cancer, diabetes, motor vehicle crashes, suicide, and homicide in 1995” (Lynch et. al., 1998, p. 1079).
More alarmingly still, of the nationally representative sample at least 51 years of age and older, “more than 25% of individuals experienced a negative wealth shock of 75% or more” during the 20-year study (Pool, et. al., 2018, p. 1344). This is supported by a 2016 study by Boen and Yang, which showed that wealth shocks experienced during the Great Recession had physiological effects on older adults, including impacting cardiovascular function, waist circumference, depression, and physiological dysregulation (Boen & Yang, 2016). Additionally, strong evidence of increased inappropriate usage of antidepressants as a result of the stock market crash of 2008 was also found (McInerney et. al., 2013). This suggests that macro-economic downturns and economic shocks have a causal relationship with increased risk for morbidity, drug abuse, and death, and are a health threat as much as a wealth threat for older adults.
Tax Collection 1980-2020
Tax collection saw a drastic change starting in the 1980’s that arguably had a profound impact on the overall revenues of the United States over the past four decades. Competing social and political philosophies have led to sizeable differences both in the nature of taxation as well as comprehensive changes to major social programs such as Social Security. What cannot be overstated are the stark differences in outcomes with respect to how these policies have impacted the bottom line and the funding gap that now exists as a result of such policies, even as major cost centers such as health care spend have become more efficient over time.
Individual Taxes vs. Corporate Taxes
Individual taxes have remained literally as constant as total federal tax revenue has over the past 40 years. According to OECD data, from 1980 to 2020 the total tax revenue of the United States has grown annually 5.22% on average, which is the exact same rate that individual income tax revenues have grown over the same time period (OECD, February 2022.). Total federal income and capital gains tax revenues (not including payroll tax) have averaged 48.53% of total revenues over the past 40 years, while during the same time never falling below one standard deviation (2.01%) in any decade. Individual capital gains tax revenues have averaged considerable tax revenue growth, increasing on average 11.35% a year during the same time period (OECD, February 2022).
Corporate tax revenues from 1980-2020 have grown annually 4.86% annually, contributing on average 6.46% of the total tax revenues (OECD, February 2022). This percentage of contribution to the total tax revenues has also been consistent, never falling beyond one standard deviation in any decade. Corporate capital gains tax revenues have also grown more quickly than taxation from profits, earning growth of 9.04% annually (OECD, February 2022).
However, there are stark differences in how tax policy has been implemented on these two populations. Individuals are required to pay a considerably higher tax rate than corporations overall, in spite of the net worth of corporations rising to $53 trillion, approximately 36% of the net worth of U.S. households according to the Federal Reserve (Board of Governors of the Federal Reserve System, December 2021). In spite of their value representing 26.7% of the total net worth of the United States, they paid just 3.73% of the total tax revenues collected in 2020 and less than 6% of total tax revenues over the past decade (OECD, February 2022).
Moreover, during periods of economic difficulty, corporations have been afforded considerably more lenient taxation measures. During the last forty years, there have been six years in which overall tax revenues have been lower than the prior year. Of those six, four of those showed decreases in individual tax revenues and two out of six had decreases in sales tax revenues (OECD, February 2022). Corporations meanwhile showed decreases in tax revenues all six of those years. Moreover, in the same forty-year timespan there have been seventeen years where personal income and personal capital gains revenues were lower from one year to the next, versus twenty-four years of year-on-year declines in corporate profit and capital gains tax revenues (OECD, February 2022). In nineteen years, corporate taxes were below their 40-year average; sixteen of those years the President was a Republican, five of those years were during the heart of the Reagan administration (1982-1986), and the three years a Democrat was President were during the Obama administration in the wake of the Great Recession. The average amount of federal income tax paid as a percentage of total tax revenues by corporations during these years was 5.24%; subtracting the Obama years, the percentage paid was 5.17%, a difference of 20% from the 40-year corporate tax contribution average (OECD, February 2022).
These taxation policies created significant amounts of debt and a structure that has not been able to grow revenues substantially to meet future obligations, in spite of the annual cost of health care decreasing over time. While the national debt tripled during the Reagan administration, health care costs were increasing at a rate of nearly 11% annually against tax revenues increasing less than 8% (Kamal et. al., November 2021; OECD, February 2022). During the 1990’s, this gap narrowed slightly, with health care costs increasing 7.11% versus tax revenues of 6.40% (Kamal et. al., November 2021; OECD, February 2022). The 2000’s saw anemic average revenue growth as the decade was bookended by the dot com bubble and the Great Recession, averaging 2.38% growth over the decade versus average health care costs increasing 6.96% over the same time frame (Kamal et. al., November 2021; OECD, February 2022). Finally, in the last ten years, tax revenues have essentially just kept pace with health care cost, with tax revenues increasing 4.47% annually versus 4.29% annually for health care costs (Kamal et. al., November 2021; OECD, February 2022). While health care costs increases have slowed by nearly 61%, the persistent lack of revenues over several decades has left the financial position of the federal government and its social programs in a precarious position.
Proposed Changes to Retirement Policies and Consequences
There are extraordinary pressures that will exist on American families and critical programs designed to serve families in the coming years and decades. Medicare and Social Security have threats to their long-term viability in delivering full benefits, with timetables for insolvency that have shortened over time. Medicaid and other income security programs face the prospect of both shortages in funding and potentially massive increases to the percentage of the population relying on these programs, particularly the senior population. These trends threaten the financial viability of budgets at both the state and federal level, eliciting considerations of a number of policy changes akin to what was delivered back in 1983 with passage of H.R. 1900, the Social Security Amendments of 1983. However, while these changes at both the state and federal levels seek to promote conditions that would sustain these programs, there are also ramifications that must be considered in the final calculus to determine just how viable these solutions ultimately are.
Social Security FRA Increase
The original Social Security Act of 1935 required that a person be 65 years of age before receiving full retirement benefits. Nearly fifty years later, standing on the precipice of running out of money, President Reagan and House Speaker Tip O’Neill brokered a deal, the Social Security Amendments of 1983, which ushered in a wave of changes to both the inflows and structure of the Social Security program. One of those key changes was the phasing in of an increase in what was considered full retirement age (FRA) over a 33-year period from age 65 to age 67 (Social Security Administration, n.d.). Combined with trigger thresholds on how much of an individual’s Social Security payments that are not subject to inflation, the vast majority of the population now pays taxes on their Social Security; this accounts for over half of total income among all households with a member age 65 or older (Thompson & King, February 2022, p. 6). Raising the full retirement age is being considered once more at the federal level.
Economic Benefits from Raising FRA
According to a 2018 paper from the Congressional Budget Office, doing this would in the near term shrink budgetary outlays by $28 billion through 2028, but by 2048 the changes would reduce Social Security outlays by 8 percent from what the law currently provisions (Congressional Budget Office, December 2018). This would close the gap with respect to underfunding Social Security from a projected 78% of benefits to 86% of benefits being paid. They go on further to suggest that if there was no change to the Social Security Disability Insurance program (DI), reducing benefits to DI would also be needed so as to not create an incentive for workers nearing retirement to stop working (Congressional Budget Office, December 2018). There are also proposals for increasing the earliest eligibility age (EEA) for participants to claim benefits, which the CBO also states would cause federal spending to decrease (Congressional Budget Office, December 2018).
Not All Aging Is Created Equal
While these policies may save the government money, there would likely be major social implications as a result of these changes based on the characteristics of the populations being affected. These differences produce stark disparities in to whom benefits are paid, how much is paid, and how it may affect those populations in the long run. The American experience is very different and the result of these changes on balance is very different depending on where an individual may fall in these demographics.
First, while the CBO cites that on average the number of additional years a person is expected to live has increased by more than six years since 1940, that increase in age is not equally distributed among the population. We know from BLS data that Black people on average live several years less than non-Black people and that Black people on average earn considerably less than non-Black people (U.S. Bureau of Labor Statistics, January 2022). Moreover, according to data from the Federal Reserve white families have three to nine times more wealth than Black, Hispanic, and other/multiple race families (Board of Governors of the Federal Reserve System, September 2020). This means that any policy that increases the age of eligibility for these programs would have regressive racial inequality outcomes, increasing income and wealth disparity between white and non-white populations as a result.
Similarly, the Chetty et. al. study on income and life expectancy shows that the gradual increase in life expectancy is not uniform and in fact is heavily skewed toward higher earning individuals (Chetty et. al., 2016). The Boen and Yang study that wealth shocks are common in older adults and that those shocks accelerate health issues and increase morbidity (Boen & Yang, 2016). Thompson and King also note that the physical requirements of lower wage work make that work more difficult to continue in older age, while higher wage work tends to be less taxing and easier for individuals to do well into their retirement years (Thompson & King, February 2022). The following income data provided by the Thompson and King report shows just how heavily lower-income households rely on income from Social Security and DI, constituting over 82% of total income for the bottom 30% of Americans (Thompson & King, February 2022). For over half of households, Social Security income represented more than half of total household income, and for the vast majority of households these benefits are far greater than income being generated through earnings (Thompson & King, February 2022, p. 6). In a similar analysis, Waldron also concluded that “the point above which differences in mortality risk by earnings become undetectable is somewhere in the top 20 percent of the male lifetime earnings distribution” (Waldron, 2013, p.24).
These findings suggest that any policy that increases the age of eligibility for these programs would withhold benefits for longer to populations of the workforce that heavily rely on them. The end result of this would be an across-the-board reduction of benefit, “with the largest proportional decline for the lowest earners” (Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population – Phase II et. al., 2015, p. 145). These policies would also increase in lower-income households a number of risks associated with physiological and mental health, including increased disease, depression, self-harm, suicide, and premature death, while simultaneously increasing the enormous disparity in wealth that already exists today between lower- and upper-income households.
Increasing Age for Required Minimum Distributions (RMD’s)
On December 20th, 2019 President Trump signed into the law the Setting Every Community Up for Retirement Enhancement Act of 2019 (also known as the SECURE Act). Boasting over 300 co-sponsors and wide bipartisan support, the SECURE Act made a number of changes to retirement savings mechanisms, including opening up multiple employer plans to non-related businesses, greater flexibility in withdrawal of funds to support family planning, student loan repayment and apprenticeships, the ability to contribute to IRA’s without regard for age, and changes to beneficiary rules with respect to qualified accounts that eliminated the ability for tax-advantaged accounts to grow for decades without paying income taxes.
A key provision of these rules that at the time may have seemed perfunctory was the raising of the age for required minimum distributions from tax-deferred qualified retirement vehicles. The SECURE Act raised that minimum age from 70.5 years of age to 72 years of age, with the rationale that it would provide more time for individuals to save money before taking their first distribution. However, the IRS tables for how much is to be distributed at a particular age did not change; under both systems, a person age 72 is required to withdraw approximately 3.65% of each account balance as of December 31st of the previous year. While ultimately this schedule delays distributions for a couple of years, it does not ultimately change the rate at which seniors must withdraw funds and pay taxes as they continue to age, irrespective their income sources and needs.
After it took four decades for Congress to raise the age for required minimum distributions, they look poised to change the formula once again. A new set of provisions first drafted in both the House and Senate in mid-2020 look to make additional adjustments to the RMD schedule. According to Sarah O’Brien of CNBC, the new House bill mandates a ten-year schedule to increase the RMD age from 72 years of age to 75 by 2032. The rationale provided, much like the last time this adjustment occurred, is that it provides seniors more flexibility in when their assets are distributed (O’Brien, June 2021).
Nerfing the Benefit of Roth Contributions
The consequences of these changes are larger than they appear, especially for contributors to Roth accounts. The first generation of people that would be affected by such a policy are those currently age 64, who according to the Uniform Life Expectancy Table from the IRS are expected to live to an age of 87.7 years (Federal Register, November 2020). This change in policy shortens the window of tax-advantaged effectiveness for Roth vehicles from 15.7 to 12.7 years, a decrease of 19.1%. During these years, another 4.13% of the overall population or 5% of the remaining population alive during that time will pass away, culling them from receiving any effective tax benefit from their post-tax contributions during their lifetime. This would likely disincentivize maneuvers such as Roth conversions. It would also ultimately force younger savers who would likely default to contributing to Roth vehicles to more seriously question whether they would ultimately benefit from the allocation. While younger individuals are expected to live longer on average, given decades of an uncertain future, the unevenness of the increased life expectancy distribution in the population, and a legislative pattern within the federal government to move the proverbial goalposts as it suits them, there are many solid reasons for an individual to question whether a Roth vehicle could ever serve them at all.
Riding the Taxpayers’ Coattails
While the increases in RMD age are being sold as a means to provide seniors more flexibility, there is another outcome that can occur as a result of these changes – increased tax revenues. While lower income households would likely continue to take distributions from tax-deferred accounts ahead of the RMD age out of necessity to pay for living expenses, individuals who are still working, are concerned about their money lasting, or just don’t need to access those funds would be more likely to wait until they are required to withdraw funds to do so. What these policies do is essentially allow the government to defer its taxation (and thus revenues) of these more stable accounts, allowing them to grow for more years before beginning to take their “distribution” in the form of taxation of RMD’s.
The revenue difference is significant. Compared with the original RMD schedule prior to the SECURE Act of 2019, this new schedule would result in an overall increase of qualified retirement account distribution revenues of 22%. Moreover, these RMD increases would also increase the overall income of the household, which in turn would potentially increase the household’s marginal tax rate, capital gains rate, and both the ratio and rate at which any income from Social Security is taxed. By the time a person is age 77, their household income would be increased by $1,000 for every $100,000 in tax-deferred investment savings versus the distribution requirement under the original schedule. With the average retirement account balance of people aged 65-75 over $400,000 according to the Federal Reserve, an additional $4,000 annually in required household income would be generated and taxed (Board of Governors of the Federal Reserve System, November 2021).
Account Limits on Qualified Retirement Accounts
It is common that changes to the tax code are done not just to generate revenue for the sake of such, but as a means of funding a particular policy; this is commonly referred to as a “pay-for.” In the various negotiations that surrounded the now-stalled Build Back Better Act, a key “pay-for” in that legislation were limits being placed on the usage and balances of qualified retirement accounts. The scope of these changes was broad, including the following:
- Prohibiting future contributions to individual retirement plans if the combined value of IRA’s and defined contribution retirement account balances exceeds $10 million.
- A new requirement that 50% of the excess balance in these account above $10 million and 100% of the excess balance above $20 million is required to be distributed each year.
- Prohibit the Roth conversion of IRA’s and employer-sponsored plans.
These provisions apply to single taxpayers with taxable income greater than $400,000, married taxpayers filing jointly with taxable income greater than $450,000, and heads of household with taxable income over $425,000. These rules would be effective for taxable years starting in 2029. There is also a provision that calls for eliminating the conversion of after-tax contributions in IRA’s and qualified plans to Roth accounts (colloquially know as the backdoor Roth IRA and Mega backdoor Roth IRA) starting the tax year after the bill passes.
On first blush, it is easy to assume that these provisions will only affect the wealthiest Americans in the top 1-2% of household income. However, a 40-year-old with $200,000 in qualified investment savings today earning 12% annually would have approximately $10.6 million in their investment accounts at age 75. Taking their required minimum distribution from qualified accounts alone would amount to $461,000 in income, which would trigger this rule. While the average 40-year-old has about $132,000 in retirement savings according to Federal Reserve data, it is clear that a much larger portion of the population than the top 1-2% would be affected by such a policy (Board of Governors of the Federal Reserve System, November 2021).
This also leads to a potential scenario where a taxpayer could lose a significant portion of their net worth, potentially compromising their economic position, with no agency or means to affect the outcome whatsoever. Taking the same now 75-year-old who has $10.6 million in qualified retirement savings, they take their first RMD of $461,000 in income. The account grows at 6% to a balance of $10.75 million, and the taxpayer is now also required to withdraw half of the amount above $10 million, or $375,000. After doing this and paying 35-37% in federal income tax on those dollars where they otherwise may not have, the market takes a downturn, and now their investments are worth 25% less. That individual, who would have otherwise had $8.1 million in those accounts after the downturn, would instead have been forced to withdraw hundreds of thousands of dollars they may not have needed, paid well over $125,000 in additional federal income tax, and would now have 3.7% less retirement savings to work with moving forward.
This is likely the kindest scenario for such a policy. Taxpayers with substantially more in qualified retirement savings could see much steeper additional required distributions and associated tax bills that they have literally no agency in whatsoever. These rules have no regard for where one lives and the cost of living in that market, nor any care for what the costs of services, particularly medical services, could amount to in the future. It forces the taxpayer to bear the consequences of an uncertain future, while simultaneously raiding their qualified investment accounts for more tax dollars if the taxpayer was fortunate and/or saved aggressively. Similar to increasing the RMD age, this policy forces taxpayers to bear the risk while the government collects heavily without any additional risk of its own.
Catch-Up Contribution Changes
Under current retirement savings and taxation rules, people age 50 and older are allowed to make “catch-up” contributions to their retirement savings accounts. Above and beyond the annual contribution limits, those who qualify may contribute up to $6,500 more in their 401(k) and $1,000 annually in their IRA. These catch-up contributions can be designated either as pre-tax or Roth basis, providing the taxpayer flexibility depending on their circumstances to choose the method and timing of how these contributions are treated.
The House version of the Build Back Better Act would adjust catch-up amounts based on inflation up to $10,000 for individuals age 60 and older, a significant expansion from the current value (O’Brien, June 2021). However, catch-up contributions would all be characterized as Roth contributions, meaning that savers would be forced to pay taxes now on dollars they wish to save (O’Brien, June 2021). This new taxation scheme is intended to be used as a pay-for to make up for shortages in other aspects of the taxation framework, such as delaying RMD’s until age 75.
According to the U.S. Bureau of Labor Statistics, people earn the most income in their career between the ages of 45-64, which nearly entirely covers the catch-up contribution window prior to reaching FRA (U.S. Bureau of Labor Statistics, January 2022). Based on median annual income and an average of median state and local tax levels, an individual would be required to pay 22% federal income tax, 7.65% payroll taxes, and a median state and local income tax rate of 10.73% combined on any dollars they wish to contribute as a catch-up contribution (Kiernan, March 2021). This means that in order to actually contribute the full $10,000 catch-up contribution, an individual would need to earn $16,772, paying $6,772 in taxes, to make that happen. Depending on what state and locality the person lives in, they would pay a net difference of 7.65%-18.38% in additional taxes; this represents a tax increase of 19%-45% over the current policy.
This contribution and taxation scheme will not affect the poorest Americans, because they do not earn enough to make this level of contribution. It will also not affect the wealthiest Americans, where this type of contribution is just another wrinkle in the tax system that they can take advantage of. But for middle-class and middle-upper class Americans, who may consider pushing their household consumption downward and curb discretionary spending to make these types of contributions for their future, these policies are punishing. Over a thirty-year period of time, the difference in returns as a result of this tax scheme assuming a 7% annual growth rate over a 30-year period of time could result in a net loss of value after tax of over $100,000. This amount represents 74% of the median value currently held by individuals age 55-64, 61% of the median value currently held by individuals age 65-74, and over 100% of the median value currently held by individuals age 75 and older. This change in policy makes it more difficult for older middle-income earners to save more during the latter part of their careers, thereby placing more pressure on the individual taxpayer and adding both increased risk and potentially increased to social insurance and safety net programs should that individual run out of money where they otherwise would not have.
A chief concern among state legislatures is the eventual wave of older Americans that will likely need the services afforded under the Medicaid program. While at least half of Medicaid is paid for by the federal government, upwards of 50% of the total cost of Medicaid is the responsibility of state governments and budgets. While all states are facing this threat to at least some degree based on demographics and time horizon, states offering more robust levels of care will face an even greater set of challenging decisions compared to states offering the bare minimum required to receive federal funding. Additionally, as the population ages and more people likely need to rely on these resources, it is likely that an amount of population movement will occur. Poorer senior Americans will likely move, if possible, to states that offer the most comprehensive care and services. This potential migration and the implications it can have on a state budget, where Medicaid already comprises 20% of the total state budget on average, is harrowing.
This problem has led to states using a variety of tactics in an effort to reign in costs. Cost-cutting strategies include reducing or freezing provider payments, setting limits on prescription drug costs, restricting eligibility and/or reducing benefits, increasing copayments, more aggressively billing third-party insurers, and attacking fraudulent claims (Smith, 2005, p. 20). Cost mitigation strategies, such as managed care programs, telemedicine, and cost-containment programs on long-term care and home-based services have also been implemented. The degree to which these programs have been successful is largely in part to how generous the state’s Medicaid reimbursement rates were. According to Duggan & Hayford, states that were already offering low provider reimbursement rates saw a negative return with respect to cost in these programs, where states with higher reimbursement rates realized cost savings (Duggan & Hayford, 2011, p.31)
Other states are taking more drastic measures. In 2019, Washington State enacted the Long-Term Services and Supports Trust Act, which included a 0.58% payroll tax starting in 2022 to fund a state long-term care insurance program called the “WA Cares Fund.” This LTC payroll tax, which applied to all W-2 workers regardless of age, health, or economic background, would provide a benefit of $100 per day, with a maximum lifetime limit of $36,500 to pay for long-term care services if an individual qualifies. However, if you pay into the system but move out of state, or do not pay into the system for at least ten years, you are not eligible to receive any benefits. The only way to avoid paying the tax was to enroll in a privately-held LTC policy by November 1, 2021. When this was announced, within days the private insurance industry was flooded with requests for LTC policies and the LTC market in Washington State has been frozen for months (Zhou, January 2022).
Additionally, this new tax policy raises serious legal questions regarding the program’s viability. Because the tax does not discern for age, younger workers who would not otherwise be considered suitable for an LTC product are now being forced to buy into a program that they otherwise would not be advised to purchase in the private market. In many cases in Washington state, particularly with the population of younger technology workers who on average make $158,000 a year, this payroll tax would cost that worker $916 a year (Soper, October 2021). This tax is nearly the same as the $950 per year premium that a single male, age 55 would pay for $165,000 of coverage. This is 4.5 times the amount of coverage offered under the WA Cares Fund, is portable from state to state unlike the WA Cares Fund framework, rated for an individual that is 24 years older than the median age tech worker (American Association for Long-Term Care Insurance, 2021; PayScale, 2021).
The WA Cares LTC tax is currently suspended while legislators work through a range of objections raised over the past several months. They are considering measures that require persistent verification that a person has carried LTC insurance every three years in order to avoid being included in the program. There will also likely be legal challenges for workers who don’t live in the state but are still required to pay the tax, age discrimination lawsuits from classes of workers that are being substantially overcharged for the service they are legally being required to maintain, and lawsuits stemming from the idea that the Long-Term Services and Supports Trust Act is preempted by ERISA. That all said, given the looming budgetary increases in the cost of Medicaid, combined with the major incoming shift in demographics occurring over the next 10-15 years, this is likely only the first in a number of efforts by states to increase revenues and defray the costs associated with senior living and care.
It is clear from current projections that funding shortfalls will exist in the future across all of our social and safety net programs, and that these shortfalls will not be transitory to a single generation. According to those projections, we have anywhere from just a few years to a little over a decade to address those shortfalls or risk a default outcome of lower benefits being paid out. Our track record regarding this topic is non-responsive. In the past, we chose policies that relied on rosy financial and demographic projections that did not account for an uncertain future and still has not adjusted for the economic realities we will face. An increase in population relying on these programs will likely occur, in orders of magnitude beyond what has ever taken place, in the next 10-15 years.
The solutions being considered are non-starters. They stymie the ability for middle and middle-upper income earners to save efficiently for older age, while simultaneously bearing the heaviest taxation possible on those individuals in a quasi “heads I win, tails you lose” scenario. Another form of trickeration exists in the creation of esoteric taxation policies such as Washington State’s Long-Term Services and Supports Trust Act, which is designed to be a gathering of wages primarily from younger tech workers to backdoor fund the state’s projected Medicaid shortfall under the guise of providing LTC insurance that that population neither needs nor wants. And while policy changes such as raising the FRA for Social Security and RMD’s may be intended to encourage working longer against a longer lifespan, the data makes it clear that these policies will likely lead to greater wealth and longevity disparity for the poorest Americans, particularly the Black population. These inequalities are avoidable and research from the WHO and others suggests that “if the major determinants of health are social, so must be the remedies” (Marmot, 2005, p. 1103).
All of these policies have four qualities in common. First, they will likely not live up to the benefits being sold by elected officials. Second, they all have a catch that results in the government raising more revenues from the general population without outright stipulating both the real costs and purposes for the revenue raise. Third, they create outcomes that increase racial, wealth, and health inequalities. Lastly, they don’t attempt to meaningfully increase taxes on the largest centers of potential revenue in the United States – the wealthiest individuals and corporations. Since the beginning of the pandemic, the top 1% or 3.3 million people have seen their net worth increase a combined $13.14 trillion, whereas the bottom 90 percent or 299.2 million people saw their net worth increase just $8.82 trillion (Board of Governors of the Federal Reserve System, December 2021). It seems unreasonable to center increased taxation policy on the massive population experiencing far less wealth generation and far greater risks of negative health, financial, and social consequences from wealth inequality. It seems far more reasonable to focus said policy on the population earning markedly more.
To that end, a method of taxation that should be considered is a graduated tax rate for corporations based on either sales revenue exceeding $26 million a year over a three-year period or are a public company. This threshold is the same threshold used to determine whether a business is required to use GAAP rules, meaning that all corporations that are required to pay this tax would be held to the same accounting standards when determining the amount to be paid. Moreover, this policy would not only not hurt small businesses at all, but could actually improve competition. According to 2018 census data, the average small business with 20-99 employees averaged $1.74 million in annual payroll, far below the $26 million threshold (U.S. Census Bureau, October 2021). 98% of all businesses in the United States have less than 100 employees. One could argue that having a layer of additional taxation based on revenues would actually create parity for small businesses, allowing more advantageous treatment of their revenues as they attempt to compete against businesses with far superior resources. This policy would also surgically target the wealth of the top 1% that historically have gained so much relative to the rest of the population without imposing a so-called “wealth tax,” which presents major legal obstacles with respect to valuation, corporate governance, and duplicitous taxation concerns that would likely spend years languishing in the court system. This approach utilizes an already agreed upon unified system for valuation to act as the referee; even a mere 5% tax on the Fortune 500 would generate upwards of $660 billion annually in revenue, not adjusted for inflation and future growth (Fortune Editors, June 2021). This would bring the level at which corporations contribute from just 3.73% in 2020 up to 13.4% of total tax revenues, which while still proportionately representing half of their net worth would more than double the total tax revenue average of 6.46% that corporations have paid over the past 40 years (OECD, February 2022).
Another potential avenue for revenue generation without placing undue pressure on the vast majority of Americans would be through either reforming or entirely abolishing the non-profit tax classification from the Internal Revenue Code. The first statutory reference pertaining to tax exemption goes back to the Tariff Act of 1894, but what we know as section 501(c) of the Internal Revenue Code was established with the Revenue Act of 1954. Since then, special rules and limitations over the past several decades have created a myriad of carve-outs and means of avoiding taxation. According to IRS filing data from 2018, 501(c)(3) organizations received $2.29 trillion in revenues, with an excess of net revenue over net expenses of $112 billion (Internal Revenue Service, August 2021). Of the 209,755 returns filed that year, non-profits with less than $50 million in revenues had more expenses than revenues to the tune of $3 billion, meaning that practically all revenues in excess of earnings are being earned by 8,285 organizations, representing just 3.9% of the total number of 501(c)(3) organizations in the United States (Internal Revenue Service, August 2021). Nearly 70% of this income is sourced from either large-scale gifts, which tend to be used to either avoid other forms of taxation such as estate taxes or to gain influence/political favor, and investment income. Even if the code were purely reformed to exempt organizations under the $26 million income threshold for GAAP accounting previously discussed, and we were to apply both the current corporate income tax of 21% on revenues in excess of expenses and a 5% tax on total revenues, $112.5 billion in tax revenues not adjusted for inflation and growth would be generated annually, representing an additional 2.28% of total tax revenues generated. This would be accomplished without affecting over 96% of non-profit organizations in the United States.
While hardly novel, other key adjustments for tax revenue improvement include increasing the marginal tax rate for the wealthiest Americans and increasing the corporate tax rate on profits. In order to be in the top 1% of earners in the United States, you would have needed to earn $597,815 in 2021, earning on average $1.7 million (CNBC, January 2022). This means that for every 1% the top marginal tax rate is raised, $20.9 billion of new tax revenue would be generated, not adjusted for inflation. By raising the top marginal tax rate to 50% from 37%, $271 billion in new tax revenue would be generated, not adjusted for inflation. With respect to increasing the corporate tax rate, raising the percentage from its current level of 21% to the OECD member state average of 26% would bolster tax revenues by $33.2 billion, not adjusted for inflation or growth (Bray, December 2021).
Finally, apart from working to right-size the contributions from the wealthiest of corporations, organizations, and individuals, there will need to be some prioritizations made with respect to how our tax dollars are used moving forward. It is clear from the OECD income tax data that individuals are responsible for the vast majority of tax revenues in the country. To that end, in order to sustain those revenues and maintain a more durable labor force, resources need to be maintained to reinvest and take care of that revenue-generating base. This means that labor programs involving education, especially skill-building and re-training, must be expanded to improve the productivity of workers throughout their career, thus taking pressure off of low-income serving programs such as Medicaid and income security safety net programs. For as much as any social program may cost, all of them are outspent individually by the over $770 billion allocated for military spending in FY 2021, amounting to more in defense spending than China, India, Russia, the United Kingdom, Saudi Arabia, Germany, France, Japan, South Korea, Italy, and Australia combined, the majority of whom are allies (Peter G. Peterson Foundation, July 2021). Even if we tailored this budget to spend 50% more than chief military rivals China and Russia, we would still save over $300 billion annually, not adjusted for inflation and growth. Moreover, this change would not affect veterans’ benefits; veteran benefits fall under the Department of Veterans Affairs with a separate FY 2022 budget of $269.9 billion (U.S. Department of Veterans Affairs, June 2021). While it would require a rethinking of the roles, responsibilities, and resources available to the military as a whole, the savings in funds could be directed toward programs that would improve the health and well-being of the entire American population. By providing more resources and ensuring a better quality of living to the vast majority of the population, one could argue that domestic terrorism, hate crimes, recidivism, and other domestic threats could be mitigated.
The problems we face with respect to the trajectory of the social programs and services the population will need moving forward are both vast and consequential. It is clear that over the past forty years, we have by and large not answered the call to make meaningful structural reforms in how we both collect revenue and prioritize revenue dollars to build and maintain a sustainable society. It is evident that the people bearing the greatest weight are far and away people of lower income, and in particular laborers and Black Americans. When thinking about the phrase “Life, Liberty, and the pursuit of Happiness,” it seems evident that we have enshrined that message as one only attainable by a precious few, at the great and grave expense of the many, and that if we do not change how we do business in this country, we will have both a humanitarian and financial crisis on our doorstep in the next ten to fifteen years.
The good news is that there is still time to act and change our trajectory to solve these problems. Health care costs have slowed their growth precipitously, and we have the ability to generate both enough tax revenues and tax savings to meet these extraordinary challenges, all with little or no consequence for all but the richest of individuals and corporations, and even they would not be burdened to a point which would affect their ability to continue to generate profits and growth for the future. What we cannot afford, and must not do, is wait until months before Medicare’s SMI Trust Fund or Social Security’s OASI Trust Fund are about to be depleted before brokering yet another last-minute deal, akin to what happened with the Social Security Amendments of 1983 that kicked the proverbial can down the road for the next generation. Instead, we need to have stark conversations about the realities of our economy, the realities of the needs of the people, and have the courage to make significant adjustments to both our revenue collection practices and spending priorities in order to meet these challenges.
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